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2008-11-11 00:14:21

The Truth About Negative Equity

Everywhere you turn, there’s someone ready to scare you into believing it’s a bad idea to own a home.

According to a recent report by First American CoreLogic, about 7.5 million American homeowners are paying mortgages that are underwater. That means they owe more than the home is currently worth. On the open market, that’s about five percent less than the mortgages they’re paying on them.

I say bunk. Here’s why. It’s not the whole story. Any time you talk about losses, it’s only fair to talk about gains, and there’s plenty of upside in housing.

Anytime you buy something, you’re underwater until time and the marketplace improves the value. I don’t care what it is – an antique, a painting, a house. Whatever you paid, that’s the top of the market at that point in time.

The truth is most of what consumers buy loses value. All they have to do is look at the cars in their driveways and the clothes in their closets. At least with houses, there’s a shot they’ll see their money again and then some.

Here’s how housing investments really work.

Governments like stability, so they heavily subsidize and reward homeowners to invest in housing. That’s what Fannie Mae, Freddie Mac and HUD’s FHA programs are for. They’re designed to make housing more affordable by keeping interest rates down, providing a resale market for mortgage equities, and keeping the river of mortgage lending money flowing.

You have to live somewhere and your choices are rent or buy. According to Ginnie Mae’s rent vs homebuying graph, homeowners paying 20 percent more than renters break even in less than three years. The reality is even better than that.

Tax breaks allow homeowners to live relatively cheaply, especially if they purchase within their means. How is that possible? Let’s take a look. If you buy a home for $100,000 and you pay 5,000 down and cash for your closing costs, about 3 percent, you’ve now got $103,000 in the home. If you have a $95,000 fixed-rate 30-year mortgage at 7 percent, you’ll end up paying $199,500 for the home.

At one percent appreciation annually, it will take you eight years to break even on your down payment and original closing costs. To sell you need an additional 8 percent in closing costs. That means your $100,000 home needs to sell for $116,000.

See why so many homeowners are stuck? But that’s why Uncle Sam steps in to sweeten the deal.

While your home is making modest gains, or losing value, Uncle Sam is making it up to you in the form of mortgage interest rate deductions (fully deductible on loans under $1 million). Let’s say the first year you own your home, your mortgage interest rate deduction is $4,000. You earned $37,000 in income to qualify for the home, and you get to take that right off the top. Now you’re paying taxes on $33,000 annually, if you don’t itemize. If you’re in the 20 percent tax bracket, that’s a free $800 a year. $800 times 8 is $6,400.

You’re starting to break even….and we haven’t started on property tax benefits. If you are a homesteader, your rate may be significantly reduced by your municipality. And, your property taxes are fully deductible. So if you’re paying $1,500 to your county and city, guess what? Now you’re only paying taxes on earned income of $31,500. Twenty percent of $1,500 is $300 times 8. That’s another $2,400.

Now you’re $8,800 ahead. Just for argument’s sake, let’s assume your property taxes haven’t risen, which is only fair since we’re about to give the same benefit to you. We’re going to assume that your rent doesn’t go up for the same period.

If you were a renter instead of an owner, you’ve been paying rent all that time of $800 per month with no tax benefits. You’ve paid out $76,800 over eight years and received nothing but a roof over your head. As a homeowner, you’re paying about $770 a month for a total of $73,920 after eight years. Subtract the $8,800 in benefits and you’re at a cool $65,120, or $11,680 less than if you’d rented.

Now let’s pop in the equity you’ve built by paying your mortgage down, about 1/3 less 20 percent for eight years. You have about $25,333 in equity just in mortgage reduction.

Now you’re $37,013 ahead if you owned instead of rented. Now you can afford to sell your house at $116,000 and still walk away with $21,013.

Granted, you’re getting some of your own money back, but that would never happen if you rented. And, look at the gain. You put down $8,000 to get into this position. Tripling your money after eight years is good. And that’s being conservative.

So stop listening to the press whine about negative equity, and go buy yourself a home.

Blanche Evans is the co-founder of evansEmedia, inc., publisher of The Evans Ezines. She is a nationally known journalist, author of five real estate books, and a popular keynote speaker for associations and brands. For more information on evansemedia and The Evans Ezine, please contact her at blanche@evansemedia.com, or call 214-686-4202. Visit evansemedia.com to view the first edition of The Evans Ezine.